informal economy of Nigeria

What is the size of the informal economy of Nigeria?

The size of the informal economy of Nigeria as at 2018 is 67% of the GDP. Specifically, the size of the informal economy in Nigeria ranges between 47 and 67 percent from 1970 to 2018, and averages 56 percent of the GDP over the same period; and that the nation, on average, losses 56 percent of her potential tax revenue yearly to informality, with the estimated tax revenue loss being around ₦3.5 trillion in 2018. Accordingly, regulation burden, unemployment, and institutional deficiency are the major drivers of informal economy in Nigeria. This is an article written by Tonuchi et al (2020).

Abstract

The purpose of this research is to estimate the size and development of the Nigerian informal economy using the MIMIC Model approach as well as the amount of tax revenue government losses every year due to the growth of the informal economy. Findings from the MIMIC model revealed that: the size of the informal economy in Nigeria ranges between 47 and 67 percent from 1970 to 2018, and averages 56 percent of the GDP over the same period; and that the nation, on average, losses 56 percent of her potential tax revenue yearly to informality, with the estimated tax revenue loss being around ₦3.5 trillion in 2018. The study concludes that regulation burden, unemployment, and institutions are the key drivers of informality in Nigeria.

  1. Introduction

This study aims to innovatively estimate the size of the informal economy of Nigeria using the MIMIC Model and the amount of tax revenue the government loses yearly to the growth in the informal economy. The informal economy continues to grow as several efforts are made by researchers to understand its size, nature, causes, and indicators. Policymakers and other stakeholders are increasingly developing interest in its development and performance mainly because of its role in poverty alleviation, employment generation, government revenue, workings of the economy, among others (Benjamin, Beegle, Recanatini, & Santini, 2014).

Though informal sector plays a prominent role in poverty mitigation, employment generation, creation of a stimulating effect on the formal economy, and acting as the ‘last resort’ during periods of economic recession and financial crisis, especially in developing and resource-dependent countries like Nigeria, it poses several economic risk and difficulties in the long term (Nguyem, 2019). Aside from making economic policies ineffective by reducing the credibility of the size of the formal economy (which serves as the basis of judging every economy), it creates several tax revenue losses, deepens the labour force unproductivity, and acts as a hindrance to a nation’s international competitiveness.

Nguyen (2019) showed that an informal economy size of 17.6 to 36.7 percent of the Gross Domestic Product (GDP) implies an average of 3.5 to 9.8 percent tax revenue loss. This argument has prompted several countries to put a searchlight on the size and performance of their informal economy. The unavailability of official statistics on the size of the informal sector in Nigeria has continued to serve as a limiting factor to several research efforts in the informal sector. And this has made it difficult to understand how monetary and fiscal policies transmit to the informal sector and the implication for the overall health of the nation’s economy. Distinguin, Rugemintwari, and Tacneng (2016) showed that it is almost impossible for an economy to achieve long term growth if the bulk of its economic activities are performed outside the regulatory purview (monetary and fiscal policies) and taxation regime. The problem with the high informal sector often experienced by developing countries is that: there is low productivity in the sector; dominated by women, and government policies to improve labour and organisation productivity are often defeated (Garzarelli & Limam, 2019). The poor performance of Nigeria and other African countries in the global supply chain calls for more attention to be paid to the competitiveness and productivity of the informal sector to increase the nation’s export at the international level in particular, and the region’s export in general. Hassan and Schneider (2016a) noted that the informal economy promotes: resource distortion; underutilisation; and bias in official data like the unemployment rate and GDP statistics.

Although some literature has attempted to estimate the size of the informal economy in Nigeria, there remain considerable controversies to date as regards the methodologies, approaches, and definition of informality. And every researcher tends to adopt different methods and approaches based on perceived peculiarities to an economy under investigation. To date, only two studies – Ogbuabor & Malaolu (2013) and Oduah (2008), have attempted to estimate the size of the informal economy in Nigeria using the MIMIC approach. While the MIMIC approach arguably remains the most favoured among the indirect approaches adopted in literature, these two studies from Nigeria suffer from possible heteroscedasticity resulting from the estimation techniques adopted. Both studies also neglect the role of institutions in estimating the size of the informal economy. Hassan & Schneider (2016a) made considerable effort to address the issue of heteroscedasticity and institution using panel data from 157 countries. However, the study failed to incorporate some critical variables that drive informality in Nigeria, resulting in the estimation of skewed trends for Nigeria. This study, therefore, seeks to address these two issues and verify the findings of Hassan and Schneider for Nigeria.

The rest of this paper is divided into four sections; section 2 provides theoretical clarification and discussion of the concept. Section 3 discusses the MIMIC Model estimation procedure and justification for the variables included, while section 4 discusses the result of the findings. Section 5 concludes the paper and proffers policy implication.

Cite as; Tonuchi, E. J., Idowu, P., Adetoba, O. O., & Mimiko, D. O. (2020). How large is the size of Nigeria’s informal economy? A MIMIC approach. International Journal of Economics, Commerce, and management, VIII(7), 204-227

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